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MBFI > SEC Filings for MBFI > Form 10-Q on 31-Jul-2014All Recent SEC Filings

Show all filings for MB FINANCIAL INC /MD

Form 10-Q for MB FINANCIAL INC /MD


31-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following is a discussion and analysis of MB Financial, Inc.'s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The words "the Company," "we," "our" and "us" refer to MB Financial, Inc. and its consolidated subsidiaries, unless we indicate otherwise.

Overview

The profitability of our operations depends primarily on our net interest income after provision for credit losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for credit losses. The provision for credit losses is dependent on changes in our loan portfolio and management's assessment of the collectability of our loan portfolio as well as prevailing economic and market conditions.

Our net income is also affected by non-interest income and non-interest expenses. During the periods under report, non-interest income included revenue from our key fee initiatives: capital markets and international banking fees, commercial deposit and treasury management fees, net lease financing income, trust and asset management fees, and card fees. Non-interest income also included loan service fees, consumer and other deposit service fees, brokerage fees, net gain (loss) on investment securities, increase in cash surrender value of life insurance, net gain (loss) on sale of assets, accretion of the FDIC indemnification asset, net gains on sale of loans and other operating income. During the periods under report, non-interest expenses included salaries and employee benefits, occupancy and equipment expense, computer services and telecommunication expense, advertising and marketing expense, professional and legal expense, other intangibles amortization expense, net loss on other real estate owned, other real estate expenses (net of rental income) and other operating expenses.

Net interest income is affected by changes in the volume and mix of interest earning assets, interest earned on those assets, the volume and mix of interest bearing liabilities and interest paid on interest bearing liabilities. Non-interest income and non-interest expenses are impacted by growth of banking and leasing operations and growth in the number of loan and deposit accounts through both acquisitions and core banking and leasing business growth. Growth in operations affects other expenses primarily as a result of additional employee, branch facility and promotional marketing expense. Growth in the number of loan and deposit accounts affects other income, including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses. Non-performing asset levels impact salaries and benefits, legal expenses and other real estate owned expenses.

The Company had net income of $23.1 million for the three months ended June 30, 2014 compared to net income of $25.3 million for the three months ended June 30, 2013. Fully diluted earnings per common share were $0.42 for the three months ended June 30, 2014 compared to $0.46 per common share for the three months ended June 30, 2013.

The Company had net income of $43.1 million for the six months ended June 30, 2014 compared to net income of $50.2 million for the six months ended June 30, 2013. Fully diluted earnings per common share were $0.78 for the six months ended June 30, 2014 compared to $0.92 per common share for the six months ended June 30, 2013.


Critical Accounting Policies

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies. Management has reviewed the application of these polices with the Compliance and Audit Committee of our Board of Directors.

Allowance for Loan Losses. The allowance for loan losses is subject to the use of estimates, assumptions, and judgments in management's evaluation process used to determine the adequacy of the allowance for loan losses, which combines several factors: management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and non-performing loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management or require that adjustments be made to the allowance for loan losses, based on their judgments about information available to them at the time of their examination. We believe the allowance for loan losses is appropriate and properly recorded in the financial statements. See "Allowance for Loan Losses" section below for further analysis.

Residual Value of Our Direct Finance, Leveraged, and Operating Leases. Lease residual value represents the present value of the estimated fair value of the leased equipment at the termination date of the lease. Realization of these residual values depends on many factors, including management's use of estimates, assumptions, and judgment to determine such values. Several other factors outside of management's control may reduce the residual values realized, including general market conditions at the time of expiration of the lease, whether there has been technological or economic obsolescence or unusual wear and tear on, or use of, the equipment and the cost of comparable equipment. If, upon the expiration of a lease, we sell the equipment and the amount realized is less than the recorded value of the residual interest in the equipment, we will recognize a loss reflecting the difference. On a quarterly basis, management reviews the lease residuals for potential impairment. If we fail to realize our aggregate recorded residual values, our financial condition and profitability could be adversely affected. At June 30, 2014, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $76.4 million. See Note 1 and Note 6 of our December 31, 2013 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2013 for additional information.

Income Tax Accounting. ASC Topic 740 provides guidance on accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements. ASC Topic 740 also provides guidance on measurement, recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of June 30, 2014, the Company had $82 thousand of uncertain tax positions. The Company elects to treat interest and penalties recognized for the underpayment of income taxes as income tax expense. However, interest and penalties imposed by taxing authorities on issues specifically addressed in ASC Topic 740 will be taken out of the tax reserves up to the amount allocated to interest and penalties. The amount of interest and penalties exceeding the amount allocated in the tax reserves will be treated as income tax expense. As of June 30, 2014, the Company had approximately $9 thousand of accrued interest related to tax reserves. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of, and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income.

Fair Value of Assets and Liabilities. ASC Topic 820 defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date.
The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in


market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.
See Note 13 to the consolidated financial statements for a complete discussion on the Company's use of fair valuation of assets and liabilities and the related measurement techniques.

Goodwill. The excess of the cost of an acquisition over the fair value of the net assets acquired consists of goodwill, and core deposit and client relationship intangibles. See Note 8 of our December 31, 2013 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2013 for further information regarding core deposit and client relationship intangibles. The Company reviews goodwill to determine potential impairment annually, or more frequently if events and circumstances indicate that goodwill might be impaired, by comparing the carrying value of the reporting units with the fair value of the reporting units.

The Company's annual assessment date for goodwill impairment testing is as of December 31. Goodwill is tested for impairment at the reporting unit level. The Company has two reporting units: banking and leasing. No impairment losses were recognized during the three or six months ended June 30, 2014 and 2013. We are not aware of any events or circumstances subsequent to our annual goodwill impairment testing date of December 31, 2013 that would indicate impairment of goodwill at June 30, 2014.

Recent Accounting Pronouncements. Refer to Note 2 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.

Net Interest Income

The following tables present, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the related yields, as well as the interest expense on average interest bearing liabilities, and the related costs, expressed both in dollars and rates (dollars in thousands). The tables below and the discussion that follows contain presentations of net interest income and net interest margin on a tax-equivalent basis, which is adjusted for the tax-favored status of income from certain loans and investments. We believe this measure to be the preferred industry measurement of net interest income, as it provides a relevant comparison between taxable and non-taxable amounts.

Reconciliations of net interest income and net interest margin on a tax-equivalent basis to net interest income and net interest margin in accordance with accounting principles generally accepted in the United States of America are provided in the table.


                                                                 Three Months Ended June 30,
(dollars in thousands)                                  2014                                    2013
                                           Average                    Yield/       Average                    Yield/
                                           Balance       Interest      Rate        Balance       Interest      Rate
Interest Earning Assets:
Loans (1) (2) (3)                       $ 5,199,981     $  53,649      4.18 %   $ 5,320,472     $  57,356      4.32 %
Loans exempt from federal income
taxes (4)                                   317,251         3,470      4.33         310,751         3,423      4.36
Taxable investment securities             1,434,300         8,794      2.45       1,377,369         6,280      1.82
Investment securities exempt from
federal income taxes (4)                    966,518        12,748      5.28         933,442        12,559      5.38
Federal funds sold                            4,359             4      0.36           2,879             2      0.27
Other interest earning deposits             448,173           277      0.25         183,010            92      0.20
Total interest earning assets             8,370,582     $  78,942      3.78       8,127,923     $  79,712      3.93
Non-interest earning assets               1,205,314                               1,161,459
Total assets                            $ 9,575,896                             $ 9,289,382
Interest Bearing Liabilities:
Deposits:
NOW and money market deposit            $ 2,880,910     $     899      0.13 %   $ 2,675,189     $     833      0.12 %
Savings deposit                             868,694            97      0.04         840,154           136      0.06
Time deposits                             1,378,201         2,758      0.80       1,700,970         4,163      0.98
Short-term borrowings                       184,204            95      0.21         189,029           116      0.24
Long-term borrowings and junior
subordinated notes                          236,266         1,344      2.25         214,839         1,390      2.56
Total interest bearing liabilities        5,548,275     $   5,193      0.38       5,620,181     $   6,638      0.47
Non-interest bearing deposits             2,476,396                               2,179,284
Other non-interest bearing
liabilities                                 199,621                                 192,553
Stockholders' equity                      1,351,604                               1,297,364
Total liabilities and stockholders'
equity                                  $ 9,575,896                             $ 9,289,382
Net interest income/interest rate
spread (5)                                              $  73,749      3.40 %                   $  73,074      3.46 %
Less: taxable equivalent adjustment                         5,677                                   5,594
Net interest income, as reported                        $  68,072                               $  67,480
Net interest margin (6)                                                3.26 %                                  3.33 %
Tax equivalent effect                                                  0.27 %                                  0.28 %
Net interest margin on a fully tax
equivalent basis (6)                                                   3.53 %                                  3.61 %

(1) Non-accrual loans are included in average loans.
(2) Interest income includes amortization of net deferred loan origination fees of $28 thousand and $817 thousand for the three months ended June 30, 2014 and 2013, respectively.
(3) Loans held for sale are included in the average loan balance listed. Related interest income is included in loan interest income.
(4) Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6) Net interest margin represents net interest income as a percentage of average interest earning assets.

Net interest income on a fully tax equivalent basis increased $675 thousand during the three months ended June 30, 2014 compared to the three months ended June 30, 2013, primarily due to higher yields on taxable investment securities partly offset by lower loan yields. The net interest margin, expressed on a fully tax equivalent basis, was 3.53% for the second quarter of 2014 and 3.61% for the second quarter of 2013. This eight basis point decrease was primarily due to higher cash balances held during the second quarter of 2014 as a result of the strong deposit inflows. Higher deposits and cash balances had minimal impact on net interest income.


                                                                  Six Months Ended June 30,
(dollars in thousands)                                  2014                                    2013
                                           Average                    Yield/       Average                    Yield/
                                           Balance       Interest      Rate        Balance       Interest      Rate
Interest Earning Assets:
Loans (1) (2) (3)                       $ 5,241,582     $ 107,595      4.14 %   $ 5,341,062     $ 115,892      4.38 %
Loans exempt from federal income
taxes (4)                                   320,371         7,006      4.35         311,128         6,895      4.41
Taxable investment securities             1,409,473        16,940      2.40       1,430,539        12,419      1.74
Investment securities exempt from
federal income taxes (4)                    951,275        25,158      5.29         922,652        24,960      5.41
Federal funds sold                            5,120             9      0.35           1,448             2      0.27
Other interest bearing deposits             318,332           390      0.25         189,994           227      0.24
Total interest earning assets             8,246,153     $ 157,098      3.84       8,196,823     $ 160,395      3.95
Non-interest earning assets               1,226,340                               1,172,219
Total assets                            $ 9,472,493                             $ 9,369,042
Interest Bearing Liabilities:
Deposits:
NOW and money market deposit            $ 2,804,688     $   1,747      0.13 %   $ 2,706,170     $   1,759      0.13 %
Savings deposit                             865,463           206      0.05         831,233           272      0.07
Time deposits                             1,406,003         5,570      0.80       1,753,640         8,810      1.01
Short-term borrowings                       192,346           195      0.20         190,458           283      0.30
Long-term borrowings and junior
subordinated notes                          229,021         2,722      2.36         231,770         2,957      2.54
Total interest bearing liabilities        5,497,521     $  10,440      0.38       5,713,271     $  14,081      0.50
Non-interest bearing deposits             2,424,917                               2,162,266
Other non-interest bearing
liabilities                                 206,597                                 204,318
Stockholders' equity                      1,343,458                               1,289,187
Total liabilities and stockholders'
equity                                  $ 9,472,493                             $ 9,369,042
Net interest income/interest rate
spread (5)                                              $ 146,658      3.46 %                   $ 146,314      3.45 %
Less: taxable equivalent adjustment                        11,258                                  11,149
Net interest income, as reported                        $ 135,400                               $ 135,165
Net interest margin (6)                                                3.31 %                                  3.33 %
Tax equivalent effect                                                  0.28 %                                  0.27 %
Net interest margin on a fully tax
equivalent basis (6)                                                   3.59 %                                  3.60 %

(1) Non-accrual loans are included in average loans.
(2) Interest income includes amortization of net deferred loan origination costs of $27 thousand for the six months ended June 30, 2014 compared to net deferred loan origination fees of $1.8 million for the six months ended June 30, 2013.
(3) Loans held for sale are included in the average loan balance listed. Related interest income is included in loan interest income.
(4) Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6) Net interest margin represents net interest income as a percentage of average interest earning assets.

Net interest income on a fully tax equivalent basis increased $344 thousand during the six months ended June 30, 2014 compared to the six months ended June 30, 2013, primarily due to improved taxable investment securities yields and a lower cost of funds, partially offset by lower loan yields. The net interest margin, expressed on a fully tax equivalent basis, was 3.59% for the six months ended June 30, 2014 and 3.60% for the six months ended June 30, 2013.


Non-interest Income

                                              Three Months Ended
                                                   June 30,
                                                                          Increase/      Percentage
                                             2014            2013         (Decrease)       Change
Non-interest income (in thousands):
Capital markets and international
banking fees                             $     1,360     $      939     $       421          44.8  %
Commercial deposit and treasury
management fees                                7,106          6,029           1,077          17.9
Lease financing, net                          14,853         15,102            (249 )        (1.6 )
Trust and asset management fees                5,405          4,874             531          10.9
Card fees                                      3,304          2,735             569          20.8
Loan service fees                                916          1,911            (995 )       (52.1 )
Consumer and other deposit service
fees                                           3,156          3,593            (437 )       (12.2 )
Brokerage fees                                 1,356          1,234             122           9.9
Net (loss) gain on investment
securities                                       (87 )           14            (101 )      (721.4 )
Increase in cash surrender value of
life insurance                                   834            842              (8 )        (1.0 )
Net loss on sale of assets                       (24 )            -             (24 )      (100.0 )
Accretion of FDIC indemnification
asset                                             28            100             (72 )       (72.0 )
Net gain on sale of loans                        187            506            (319 )       (63.0 )
Other operating income                         1,534          1,060             474          44.7
Total non-interest income                $    39,928     $   38,939     $       989           2.5  %

NM - not meaningful

Non-interest income increased by $1.0 million, or 2.5%, for the three months ended June 30, 2014 compared to the three months ended June 30, 2013.

Commercial deposit and treasury management fees increased due to robust new customer activity.

Card fees increased due to a new payroll prepaid card program.

Trust and asset management fees increased due to the growth in investment management fees as a result of new customers added and the impact of higher equity values on assets under management and related fee revenue.

Capital markets and international banking service fees increased due to higher M&A advisory and syndication fees.

Loan service fees decreased due to lower late, prepayment and miscellaneous loan fees collected.

Consumer and other deposit service fees decreased due to lower demand deposit service and overdraft charges.

Net gain on sale of loans decreased as a result of less mortgage origination activity.


                                              Six Months Ended
                                                  June 30,
                                                                         Increase/     Percentage
                                             2014           2013        (Decrease)       Change
Non-interest income (in thousands):
Capital markets and international
banking fees                             $    2,338     $    1,747     $       591         33.8  %
Commercial deposit and treasury
management fees                              14,250         11,995           2,255         18.8
Lease financing, net                         28,049         31,365          (3,316 )      (10.6 )
Trust and asset management fees              10,612          9,368           1,244         13.3
Card fees                                     6,005          5,430             575         10.6
Loan service fees                             1,881          2,922          (1,041 )      (35.6 )
Consumer and other deposit service
fees                                          6,091          6,839            (748 )      (10.9 )
Brokerage fees                                2,681          2,391             290         12.1
Net gain on investment securities               230             13             217           NM
Increase in cash surrender value of
life insurance                                1,661          1,686             (25 )       (1.5 )
Net loss on sale of assets                      (17 )            -             (17 )     (100.0 )
Accretion of FDIC indemnification
asset                                            59            243            (184 )      (75.7 )
Net gain on sale of loans                       246          1,145            (899 )      (78.5 )
. . .
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